US stock market confirms primary downtrend

“Winter, spring, summer or fall, all you have to do is call, and I’ll be there, you’ve got a friend …” These are the lyrics of Carol King’s song. Yes, as life swings from boom to gloom it is the support of friends that often provide the necessary solace.

It is unlikely that Mr Market will come patting you on the back when your investments go pear-shaped, but he does provide his own unique variety of comradeship. In an environment cluttered with noise, Mr Market offers us the very simple but true adage of “the trend is your friend”. This sounds comforting enough, but Mr Market still expects us to fulfill a task: to identify the direction of the trend.

An important point to realize is that there are trends within trends, varying from ultra short (intra-daily) to short (daily) to intermediate (weekly) to long term (monthly). Although day traders play short-term trends from minute to minute, I believe that it is really the identification of the primary (multi-year) trends that holds the key to successful investing.

One way of approaching this is to gauge the fundamental landscape – factors such as unfavorable valuations, stretched profit margins, mounting evidence of an imminent recession and increasing default risk. These paint a fairly bleak picture, but keep in mind the discounting nature of the stock market, having already factored in the gloomy news we are faced with 24/7. In order for the market to fall further the nature of the problems should turn out to be broader and deeper than currently discounted. As mentioned previously, I believe that the fallout of the housing and subprime situation has not been fully discounted.

A more visual way of recognizing the primary trend is by means of analyzing the technical picture, especially using a longer-term perspective.

The following graph indicates how the Dow Jones Industrial Index has been mapping out a series of lower lows and fallen below its 200-day moving average (often seen as an indicator of the primary trend). The shorter term 50-day moving average is trending down and provides an early indicator of what is in store for the longer-term average. The Index has just dropped below its November low on increased volume, serving as further confirmation of a downtrend.

The chart below shows the percentage of stocks on the NYSE that are trading above their 200-day moving averages. As of yesterday’s close the reading was 28.1%. This is the lowest reading in five years and indicates that more than seven out of every 10 stocks are in primary downtrends. Although the current level appears low, the number has fallen as low as 10% at previous bear market bottoms (such as 2002).

Next is the 10-year graph of the NYSE Composite Index (based on monthly data), indicating the price trend together with the MACD oscillator. The failed year-end rally in December witnessed the histograms falling below the zero line (see blue circle) for the first time since the start of the bull market in 2003. (The previous MACD sell signal was given eight-and-a-half years ago in July 1999.)

Turning to a monthly graph of the Dow Jones Industrial Index, a similar picture emerges when using the 14-month RSI oscillator. This indicator is overbought at levels above 70 and oversold below 30. The RSI’s trend is now falling for the first time since the bull market commenced in 2003.

My assessment of the above is that there is more weakness for the stock market ahead. Although the market is oversold on a short-term basis, I would be very reluctant to take long positions in the face of what I believe is a market topping out and embarking on a primary downtrend. I therefore concur with Nouriel Roubini, professor of economics at New York University, when he says: “… a lousy stock market in 2007 will look good compared to an awful stock market in 2008.”

I wrote a series of bearish articles on the stock market (and bullish on gold) during the latter months of 2007 of which the last one on December 17 was entitled “Is this the end of the stock market party?”. Mr Market has provided the answer and it is a rather discomforting one. Yes, “the trend is your friend”, but only if you heed Mr Market’s warnings and appreciate that the stock market is in a downtrend. Be inordinately cautious with your investment strategy.

15 Responses to “US stock market confirms primary downtrend”

Became aware of Prieur’s excellent site and postcards via John Mauldin. Today’s article is filled with predictions supported by stacks of relevant data. Very useful. Well done.
Mike.
Living in Oz i have never come across the name Prieur. Is it french? How does one pronounce it? Just curious.

I like your approach and conclusions but behavioral patterns are important too. Mr Market is just a player at a poker table with a crooked dealer (Brokers) and shills (Paulson, et al) leading him on. Here is a link that shows (2nd chart) the pattern of Mr Market dropping and then going up into rate cuts (next cut on Jan 30).http://tinyurl.com/2j5uzp

Thanks for including my comment above, but when passing the cursor over my link the “snap shot” does not show the correct chart from that link for what I remarked above. One must actually click the link and look at the chart below the “snap”.

I am thoroughly amazed that you would rely upon such poor tools as the MACD cross or the relationship of prices to their “key” MA’s to guide your investment analysis. I realize that these are just one “point of light” shedding insight onto a complex problem but there is little evidence to suggest any of your technical “insights” really amount to anything. So I ask: “why say them?”

Guy: We all have our own unique sets of tools that we use for guiding us. I believe that there is no single tool offering a total solution. I study numerous fundamental and technical indicators (of which MACD and moving averages are a few), but in the end it is not a question of relying on any single indicator in isolation, but rather using the composite, combined with multi-year experience, to arrive at educated answers. Please feel free to share with us the conclusion of your analysis and suggested investment strategy.

Prieur: First let me say that I or no one that I know of has the “lock” on investment analysis. But what gets me about investment analysis in general and particularly TA (because this is what I do) is how much is accepted as a matter of fact. For example, take the MACD “sell” signal. I would ask what does that really mean for prices going forward, and I would look at how such a signal affected prices in the past to determine how such a signal might affect things going forward.

We both know that there is more to market analysis than just two lines crossing on a graph. It cannot be that easy.

My work or market analysis is very much influenced by books like “Evidence Based Technical Analysis” or other commentators like Dr. John Hussman. I am not Dr. Hussman (by any stretch) but I understand and appreciate his rigorous/ data centric approach.

My apologies if I came off a bit strong, but good analysis is something that I am passionate about. And that’s why I keep reading your site because I enjoy the insights you are bringing to those (myself included) who do not have access to such information.

There is a healthy balance between common sense and scientific rigor in the markets. Those who over simplify everything tend to sound like idiots when things happen in more detail, and those who get swamped in the details can’t see the forest from the trees.

I think Dr. Prieur’s chosen charts clearly indicate a downward trending market. If you disagree, explain where the problems are. Don’t say X is better, say WHY and show evidence. The charts above seem to speak for themselves as data points to consider when investing. They are not perfect independently of additional information. But the set of 4 above make a solid case for Dr. Prieur’s thesis.

And what is your “analysis” of lower highs and lower lows on increasing volume? Is that bullish or bearish? Supply and demand are still the core of capitalism.

A smart investor looks at different data and makes a holisitic analysis. The PhD’s at Long Term Capital proved that SCIENCE alone does not make for solid investing. These type of “scientific” quants blow up all the time. And asking your neighbor how they feel about the economy is not going to help you beat the markets. There is plenty of evidence proving that ALL types of funds using every type of strategy blow up.

As an attorney, I can find flaws with every single argument — and I’m sure you can too. That’s why criticism is meaningless without proper evidence. And at this moment, Dr. Prieur has been spot on calling the downturn. So, to date, he is correct.

SmartGuy: I would totally agree with many of your statements including: “There is plenty of evidence proving that ALL types of funds using every type of strategy blow up.”

My point in all this is 1) not being too dogmatic in our points of view 2) base opinions (at the very least) upon the data. In my opinion basing your analysis on anecdotal observations (like only looking to the left side of the chart) is not rigorous. What I want to know is the significance of every prior MACD “sell” signal; without even running the test, I can guarantee you it would have led to underperformance.

Within the context of numerous other data points, I don’t doubt that the current MACD sell signal is coincidental.

With regards to market calls, I have written the following in other venues. On July 30: “If new marginal highs in the major indices are seen without a turn in sentiment than I believe that such an occurrence will cement a market top leading to a bear market. Marginal lows often lead to marginal new highs, and this kind of price behavior is seen at market tops that play out over months.” On August 27: “I consider the low that was made in February, 2007 a marginal low. The highs made in July were marginal highs. If the markets continue higher from this point, August will be another marginal low. Marginal lows lead to marginal highs and this is what makes a market top.”

By the way, these were observational findings – my geshtalt if you will- regarding various trading signals that occurred around these times. Despite my sense that we were putting in a market top back in July, I didn’t run for the hills; actually 75% of my market exposure was from the long side in the last 4 months of the year. Observations that’s all!!

Thank you for the nice discussion; I appreciate hearing what others are thinking!

Following last week’s sell-off, the US stock market seems to be topping out and embarking on a primary downtrend. This view is confirmed by both the fundamental and technical pictures and calls for inordinate caution with investment strategy.

Everyone seems to be betting on recession, however very few seem to have contemplated the possibility of a slowdown just short of recession. Or perhaps we’ve been in a mild recession say since October, which won’t show up for months. Markets factor in the end of recessions with the second half of a “V” shape, which should be starting right about now. In the past, gains of 10-33% have been recorded even before the economy had begun its recovery. Its not recession we need to be concerned about…..it’s Depression and that’s still quite a ways off. This final pullback, when all optimism has been wrung out of the market, is likely the best time to buy. While there can be 3 sets of a-b to extend the downside (or the upside) once the count is complete, in most stocks we are there now.

At today’s prices the market has factored in that 70% of all sub-prime debt will default… a bit extreme, for so early in the game.

The traditional hedge against recession is gold. Although the US Dollar is on the rise, everyone is still holding on to last year’s expectation of a continued slide….this, coupled with recession expectations, is the primary contributing factor to gold’s recent glitter. However, once it becomes clear that there’s no recession on the horizon and that the dollar will not repeat last year’s performance, gold will plummet and the market take off. To see the version with charts follow the link to archives below.

Yes the economy is slowing down but there are companies that will still make a profit regardless of a recession because people are not going to change their spending habits.

They may cut down on bigger purchases like homes and cars … but saving a dollar here and there will not make a difference on your income.

Don’t forget the global markets and the demand for our American products!

In terms of the comment stated above are you going to buy less groceries to save 10 bucks or so? Will you stop drinking coffee? Will you stop using toilet paper? Will you stop using your Mastercard?

Yes you may not buy a bigger house or may not buy a fancier car to save money but your small expenditures will still exist.

Now for the global markets – India & China for tech products are increasing especially with the iphones, laptops, microsoft software, and of course cars! People are getting richer in India. College and high school students are getting jobs at call centers which pay them above the average means and yet they live at home with their parents. So what will they spend their money on? Of course- tech gadgets and clothes!

With global growth I don’t see how US companies can suffer a loss instead they will be growing maybe not as fast as they should but they will be growing – so don’t panic selling your stocks thus dragging the market down!